Thursday, April 28, 2005

Is Value Dead? Again?

For the past five years, value has trounced growth. The S&P 600 Smallcap Barra Value Index, for instance, is up an average of 13.1 percent per year during the past five years, versus just 5.4 percent for the S&P 600 Smallcap Barra Growth Index. For the past year, however, the gap has narrowed, with value barely beating growth (7.68 percent versus 7.62 percent). Are the days of value outperforming growth coming to an end?

The folks at Tweedy Browne & Co. recently sent a sobering letter to shareholders, which announced that both of the company’s funds, Tweedy Browne American Value, and Tweedy Browne Global Value will close to new investors on May 4, 2005. “What’s the big deal” you may wonder? Funds close all the time, usually because there’s too much cash coming in, and not enough places to put it and maintain the funds objective, right? True as that may be, in Tweedy’s case, it’s the stated reasons for closure that have this value investor scratching his head.

The letter quotes fund manager Chris Browne saying:

“Current stock market levels worldwide present few investment opportunities selling at an attractive discount to intrinsic value. Moreover, certain holdings of both Funds have risen to levels of full value in our view, resulting in both funds being net sellers of securities”.

As a long-time shareholder of Tweedy Browne American Value, and believer in the firm’s investment process, that statement is scary.

The fact that Tweedy can no longer find investment ideas that fit its stringent criteria, may mean that value is dead, at least Tweedy’s definition of value. While their honesty is refreshing—and I believe these guys always tell it like it is, a rare virtue in this industry—I can’t help but question whether to cut and run. Afterall, if they can’t find any suitable investments, does that translate into lackluster returns for these funds in the next couple of years?

Chris Browne’s comments continue:

“Since the collapse of the technology, media and telecommunications bubble in 2000 wrung out the grossly inflated excesses of the so-called growth sectors of the market, the more mundane value stocks have risen to levels at or near their private market values. The result is that the price difference between the most expensive and the least expensive stocks is narrower than we can recall in more than 30 years. Current cash levels at both funds provide more than enough “dry powder” to take advantage of buying opportunities when they present themselves. At the present time, having no limits on allowing new investors into the Funds could excessively dilute existing Funds shareholders’ investments in a limited pool of cheap stocks.”

To put Browne’s comments into perspective, thirty years takes us back to the mid 70’s, not a great time for investors. Browne’s words are certainly disheartening.

For those of you who are not familiar with Tweedy Browne, this firm once served as Ben Graham’s brokerage firm. They are true dyed in the wool value investors, seeking to buy firms well below intrinsic value: companies trading at low price to cash flow, low price to book, low P/E ratios, low price to sales ratios. They like management to have a stake in the company, and that insiders are buying, not selling. The Investment Research and Reports section of their website is a must for anyone interested in value investing. One report entitled "What Has Worked In Investing" provides excellent insight into the company’s investment philosophy, and even discusses one of the topics this site is devoted to—companies trading below their net current asset value.

The author has had a position in Tweedy Browne American Value for years, and continues to add to it on a monthly basis. The fund is not a high flyer, but provides decent risk adjusted returns. For the past 5 years through March 31, the fund has averaged 5.45 percent per year versus (3.16) percent for the S&P 500. That’s a spread of more than 8 ½ percent.

I think I’m coming back to my senses. Value isn’t dead, value never dies. Maybe it’s on hiatus. When it returns, the boys at Tweedy will pounce. I’m keeping my Tweedy Browne American Value shares. Thank you (managing partners) Chris Browne, Will Browne, John Spears, Tom Shrager, and Bob Wyckoff for your honesty. We need more like you in this industry.